Don't believe rumours of deep recession
U.S. is making all the right moves to avoid a lengthy downturn
In the week when trading resumed after the September 11 terrorist attacks, the U.S. stock market fell 14.3 per cent. Some investors took the depth of that setback as a sign that the attacks would send the U.S. and the world into a deep recession.
At times like this, however, it pays to remember that the stock market has a poor record for predicting recessions.
As the saying goes, it has predicted "...nine of the past five of them."
Similar predictions arose following October 19, 1987, when the Dow Jones fell 22.5 per cent in one day. But the stock market began to rebound almost immediately. It is now around five times higher than it was at the 1987 low.
The recession, widely predicted for the months following the 1987 crash, only materialized three years later, in Fall, 1990 ? and then only after Iraq invaded Kuwait and set off an overnight tripling in the price of oil.
I wouldn't suggest that today's situation is identical to 1987's. But there are similarities.
For instance, in both cases the U.S. Federal Reserve stepped in and injected a great deal of cash into the banking system. That made credit easy to get and pushed interest rates down. In both cases, the market began to rebound soon after the sell off.
It's a mistake to interpret a single fact or incident as a guide to the future.
Prior to September 11, the economy was already weak. The terrorist actions may push us over the edge to two calendar quarters of economic shrinkage, the traditional definition of a recession.
But the airlines and related industries such as hotels may suffer most of the damage.
Meanwhile, the banks and utilities we've recommended have held steady or gone up. That's all the more reason to follow my standing advice about diversification, to cut your risk and take advantage of today's two-tier market.
The U.S. Federal Reserve has cut interest rates three times for a total of 1.5 per cent since September 11. That drops rates to their lowest level since 1962. The Fed has now cut rates nine times so far this year. It also made it clear that it will cut rates further if needed.
The Fed is cutting rates to buoy consumer confidence and energize the economy. The economy was already weak, although there were faint signs of a recovery. The U.S. government is also taking major steps to stimulate the economy.
Congress has already approved a $40 billion (U.S.) emergency spending plan and a $15 billion airline aid package. President Bush is now asking Congress to approve a further stimulus plan of between $60 billion and $75 billion.
This plan will comprise tax cuts for individuals plus business tax cuts and investment tax credits. It will also include relief for laid-off workers.
The U.S. government is also considering speeding up the huge $1.35 trillion (U.S.), 10-year tax cut passed earlier this year. The reduction in individual tax rates scheduled to go into effect in 2004 could be moved forward to next year, boosting consumer purchasing power and stimulating the economy.
Before the attacks, consumer spending remained strong enough to offset falling business spending and keep growth positive.
The latest moves may be enough to keep consumer spending active and also to restore business spending.
If so, the combination of an economic turnaround, very low borrowing rates and lots of money in the system could be a powerful economic stimulus that will push up prices of stocks and mutual funds.
Portfolio manager Patrick McKeough publishes investment newsletters and is author of Riding the Bull: How You Can Profit in the 1990s Stock Market Boom. Visit him online at The Successful Investor or call 1-888-292-0296.
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